Global uncertainty highlights the need for a cautious approach to India's macroeconomic policy

The world's economic policymakers are gathering this week in Tokyo for the annual meetings of the International Monetary Fund (IMF) and the World Bank. The location of the meetings in Asia offers an opportunity to reflect on the IMF's outlook for the economies of Asia, including India.

First, it's important to take stock of how the global economy is faring. The IMF continues to project a gradual recovery, but a bit weaker than we had earlier expected.

We currently forecast global growth of about 3.3% in 2012, rising to 3.6% in 2013 (details are available at www.imf.org/weo.) As has been the case for some time, emerging market and developing economies are growing more rapidly than the advanced countries.

Also important to note is the fact that this projection is predicated on two assumptions: first, that euro area policymakers will adopt policies sufficient to ease financial conditions in countries under strain and, second, that US policymakers will find a way to avoid the drastic spending cuts and automatic tax increases, the so-called 'fiscal cliff', implied by existing budget law.

However, we have seen also a deceleration in major emerging markets and, as our managing director has said, "the illusion of decoupling has vanished".

What about Asia? Taking advanced, emerging and developing countries together, Asia's GDP growth was about 5½% in the first half of 2012, the lowest figure since the 2008 global financial crisis erupted.

In part, this result stemmed from weaker demand in Europe and the US, but domestic factors were also important, especially in India and to a lesser extent in China, while Japan slowed as reconstruction efforts abated.

The good news is that several of the Asean countries, especially Malaysia, Indonesia, the Philippines and Thailand, continued to grow at or near potential.

Compared with recent years, the near-term outlook for Asia is lacklustre with 5.5% growth projected for 2012 and 6% for 2013. Consistent with this modestly reduced growth outlook for Asia, inflation has slowed in most countries, in several cases reaching the comfort zones of central banks in the region.

But what could go wrong? The main downside risks to the forecast above come from the euro area and the US 'fiscal cliff'. China has become an engine of growth in the region, so while remote, the chance of a 'hard landing' there would have important spillover effects to a number of key partners in Asia.

On a value-added basis, two-thirds of emerging Asia's exports are linked to demand from the US or Europe. A sudden rise in global food or fuel prices could also hit growth across Asia. Based on our models, there is a one-in-seven chance of Asian growth being below 4% in 2013, close to the rate last observed in 2009.

What does this mean for India? India is, of course, linked to the slowing global economy, so it should not be surprising that the IMF's economic outlook for India is also weaker.

In addition, domestic factors have also played an important role in India's slowdown. For 2012, we envisage real GDP growth of 4.9% in 2012, rising to 6% in 2013. (These figures are at market prices.

The corresponding figures at factor costs and for fiscal years, as the Indian headline data, are 5.6% for 2012-13 and 6% in 2013-14.) Inflation is likely to remain elevated, with consumer prices projected at just over 11% this fiscal year, falling to 9% next year.

What does this entail for economic policies in India? The uncertainty that characterises the global economy highlights the need for a cautious approach to macroeconomic policy.

On balance, we feel that India would be well-served by keeping some power dry in the form of fiscal and monetary policy over the period ahead. But to return to high and sustainable growth, India will want to address supply bottlenecks and continue structural reforms, accompanied by fiscal consolidation over the medium term.

Recent measures to reduce untargeted subsidies, putting public finances on a stronger footing as well as the measures aimed at further opening up to FDI are positive steps that should help in this endeavour.

Continuing on this road will ensure that India is doing its part to ensure better living standards for its people and contributing to the global recovery.